ATC 2012: Fiscal stability in the extractive industry

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For investors in the mineral and petroleum extraction industries, perhaps one of the biggest fears is that the host government will introduce measures that erode the economic viability of a project. In the developing world, fiscal stability is often sought through contracts that guarantee that the laws in force at the start of the project will continue throughout its life. In the face of growing resource nationalism, however, a question mark has arisen over the strength of this kind of security.

She said while the data is still relatively raw, it emerges that a substantial number of the countries surveyed are amenable to entering into an FSA. Some countries will consider FSA's in both the mining and oil and gas industries. Others will do so only in one of the sectors, but not the other. This is because, in developing countries, extractive industries are often the principal source of government revenue. Instead of being dependent on citizens for tax revenues, these governments depend largely on foreign companies and attempt to obtain the FDI at any cost, at times not considering the impact of the agreement entered into.

“Interestingly, all of the countries surveyed maintained that FSA's were binding on the government in terms of tax law or domestic contract law and that there would be implications for the State if it breaches a FSA”, Hazell said.

Yet a number of countries, such as Guinea, Burkina Faso, Rawanda, Tanzania and Zambia, have in fact renegotiated or withdrawn FSA's in the last two years. “It is cause for reflection that while naked breaches may not occur, what can happen is that changes are effected to the legal regime, which are then used to justify the government's inability to honour the FSA, especially where renegotiation clauses are included in the agreements instead of stability clauses”, said Hazell.

She said it is important to note that whilst stability clauses may not deter a host government from being tempted to renegotiate an agreement, it does provide the investor with a stronger bargaining power, even if it is on arbitration only.

The message that is coming through for investors, says Hazell, is that while securing an FSA may turn out to be worth the trouble, they should be entered into with a measure of sceptism about the level and duration of the security they actually provide. “FSA’s were never intended to remove a country’s sovereign right completely and investors should make sure they fully understand what it is that the host government has agreed to”

Namibia is one of the countries that is not, generally speaking, amenable to entering into FSA's. Deputy Finance Minister, Calle Schlettwein explains why: “We say that if you have a track record of stability, have a sovereign credit rating, are able to commit to anti-money laundering and such like, then there is no reason why one should guarantee fiscal stability.”

Hazell noted that Ghana is going through a very similar process, in that 15 years ago, when it entered into many FSA’s, the economic and political landscape was very different from what it is today. This has prompted the Government to question the wisdom of the FSA’s that were in place in Ghana.

Schlettwein said while there must be security for investors there must also be a limit on the extent to which developing countries should forfeit revenues and policy space in order to try and attract them.

“In Namibia we will treat any agreement in regard to the taxation of an extraction project in the same way as we would treat a public private partnership. Guarantees of any nature must make economic sense for both parties”, Schlettwein said.

In this regard, Hazell says “I think the days of one sided FSA’s which only benefit the investors will become more and more of a rarity as the wave of nationalism continues to gain momentum. Agreements entered into with Governments where there is political conflict and little democracy should be viewed for what they are – a limited guarantee with limited inherent value. There certainly is still a place for FSA’s in the extractive industry, but an investor should be very clear on what guarantees are actually being received, which often boil down to mere recourse for compensation in the case of breach.”

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